A way to sustainable automobile production: game theory view

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Master’s degree thesis

LOG950 Logistics

A way to sustainable automobile production: game theory view

Author: Mikhail Zvyagintsev

Number of pages including this page: 52

Molde, 2018

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Abstract

The problem of unsustainability of the world automobile industry leads to inefficiency, inconveniences and financial losses for economies, society and environment.

The way the industry has developed during all its history offers no effective solutions to this problem. The present work argues in favor of a major change of the standard industry business model as the key method for improvement of sustainability. It aims to test how good are chances for a car manufacturer with the sustainable business model to be competitive on the market. Basing upon the oligopolistic nature of the car market, where strategic actions of each player have influence on actions of other players, this work uses game theory as the methodology. The Micro-Factory Retailing (MFR) concept is chosen as an example of highly sustainable automobile production. The forecast of viability for this concept is made by means of games played between a speculative startup and the groups of existing car brands that the startup is going to compete with. Scenarios that are most likely to develop, are represented by Nash equilibria of these games, and include Startup player opting either for MFR or traditional production and Cluster player, that can either actively fight the opponent or accept its presence on the market. The results show low competitiveness of the MFR model in the groups of brands with high focus on innovative technologies, and higher competitiveness in the groups where customer service level or total cost of ownership are of high priority for end customers. There is a number of limitations in the study, originating from simplified and generalized game model and incompleteness of the value chain analysis. By removing these limitations, one will be able to get more precise and in-depth results in further studies of this subject. Another important question to be addressed in the future is how the established car makers can find good incentives to change their methods of work to more sustainable.

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1.0 Introduction and literature review

1.1 The problem of unsustainability in the automotive industry

Sustainability is traditionally defined as an ultimate expression of its three dimensions – economic, social and environmental sustainability [2]. It’s how good a product category, supply chain or industry can sustain its normal functioning and development without negative consequences in these three dimensions. A sustainable industry is one that considers economic, social and environmental costs of production and consumption of its products during their entire life cycles.

How sustainable is today’s automobile industry? Does its sustainability get higher or lower year by year?

Among automobile manufacturers a lot of sustainability reports are made by industry representatives every year. They present figures that overall show slow but certain improvement of sustainability parameters in the industry [1]. However, even while telling the truth from a statistical perspective, the industry struggles to give somewhat deeper overview than that, when it comes to a holistic vision of the perfect automobile industry from all stakeholders’ standpoint. In addition, I haven’t found any comprehensive overviews of sustainability development for the global car industry. This fact, together with a review of the SMMT 2017 UK Automotive Sustainability Report raises questions: Are the sustainability concepts that are claimed in the industry reports, feasible and suitable for all the stakeholders? How do we know that they are not mutually exclusive? At least some of the KPI’s in this report do not look very suitable to include in the sustainability report, for example Total number of cars produced. Why should it be there? And why does the report include quite a little attention to the current problems of the industry – problems that annually cost a lot to the economies, societies and environment? The status quo is as important for our complete understanding as the goal of sustainable development, because only knowing both well, we can estimate the workload necessary for the full transition to a sustainable industry.

Furthermore, there is a variety of articles focusing on particular problems of sustainability of the industry and proposing ways of solving them. This category of articles is created primarily by independent experts, contrary to the previous one [1], where authors are often directly employed by the industry. In my work I decided to start with description of the existing problems, sustainability goals that industry should proclaim, and main

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barriers on the way to reaching them, all this from the perspective of articles I have found on the subject. This section will aim to comprise the automobile as an entire phenomenon, including not only production but the rest of lifecycle issues as well. And by this means, it will shape the scope of analysis for the rest of the work.

1.1.1 What makes the industry unsustainable

As the overall complexity of car systems grows year by year, so does the complexity of their failures. The background of the problem is simple: even though reliability of single components has definitely done a significant progress during the whole history of car engineering, the ever-increasing complexity makes car failures happen. And, the character of the failures is changing: the focus gradually shifts from mechanical to electronic components, from replacement of single parts to complete assemblies, and from predictable to unpredictable failures [3]. Even though modern cars fail less often than their predecessors, average time spent per failure as well as economic cost involved, is now higher than ever before. I have specified this issue as “Disparate durability of car components”, where the word disparate depicts uncertainty for car owners, dictated by increased qualitative and quantitative complexity and degree of unpredictability of failures. The negative consequences of this issue, described in the three sustainability dimensions, are always present. For a manufacturer, a certain design or assembly flaw can cost millions of dollars paid for a recall campaign. Economies of end users bear losses in cases when failures are not covered by campaign or warranty. End users also waste time for repairs, regardless who pays for them. And the environment suffers from scrappage of components, which on a grand scale turns out to be a severe abuse of resources, thinking of all the cases of scrapping of complete assemblies instead of only replacing small parts inside them, along with scrapping good parts by mistake in process of diagnosis of complicated malfunctions.

As another issue, I have included the tendency of manufacturers to produce cars over the level of demand. Nieuwenhuis et al. even mention overproduction as the main issue leading to unsustainability of automobile as a system [4]. For manufacturers, this attribute of economies of scale plays out as extra costs of unnecessary production and losses due to unsold new cars (including transportation, storage and handling). End users get their new cars rapidly depreciating due to oversupply of newer models.

Wells [5] indicates that the automotive industry, as the largest single manufacturing sector in the world, constitutes a major consumer of raw materials accounting for about 16%

of global steel use (and nearer 40% of high-grade wide strip steel), 30% of aluminium, 5%

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of plastic, 85% of magnesium die casting and significant proportions of other materials such as rubber and copper. For manufacturers this means high costs of production, which they try to mitigate by development along the lines of economy of scale. High usage of non- renewable resources in the industry is of course an environmental problem too.

High total cost of ownership (TCO) for modern cars is a logical consequence of ever- rising standards of safety and environmental performance, as well as manufacturers’

response to increased customer expectations in all segments. However, TCO is also a product of industry’s business model. For practically all of today’s cars it is driven by markups and maintained by car dealerships. To my mind, this combination keeps the model from being truly cost-efficient, because cars are followed up along the lifecycle by organizations totally different from those that make them. And so, the long-term interest mismatch is in this case inevitable. Dealers are pure sales organizations; therefore, it’s natural to expect financial income to be their first priority, while customer loyalty may have not as significant meaning for them as for manufacturers. Meanwhile, magnitude of TCO is to high extent defined namely by dealerships, making all the aftermarket maintenance of cars. High TCO can in long term contribute to erosion of new car sales due to lower willingness to pay. End users of cars get losses from two sides – higher investments in own cars that they would like to make, and fast depreciation of those cars (fueled also by other factors). Low economic viability of repair leads to premature scrapping. This is additional overload of environment, which should be avoided in a sustainable industry.

Finally, there are two issues that are related to car usage rather than production.

Pollution by internal combustion engines costs a lot to manufacturers, governments and end users in material terms, due to high complexity of car engine systems, as a result of tightening norms. Health problems, climate change and other environmental damages are common problems caused by pollution.

Cars, when used in densely populated areas, take huge spaces on roads and parking lots, which heavily affects traffic and human-friendliness of streets and public places. There is a number of factors, integrated the into common category “Inefficient car usage patterns”, leading to that. Public authorities try to solve this issue with better road planning and imposing of restrictions on traffic, which costs certain effort and money. Car users waste time in heavy traffic, while cars consume more fuel per kilometer and tend to get higher wear and tear. Naturally, societies and environment close to areas with high traffic take hit.

Table 1 shows the summary of sustainability issues and their consequences.

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Issues Consequences

Economic Social Environmental

Disparate durability of car components

- Manufacturers bear recall campaign expenses

- End users pay extra money for repairs

- End users waste time for repairs

- High scrappage rates of components

Overproduction ^- Extra costs of unnecessary production

- Losses due to new cars not sold within year of production

- Fast depreciation

- Transportation and handling of overproduced cars

Very high resource intensiveness of production

- High

production costs for manufacturers

- High usage of non-renewable resources High TCO for end

users of cars

-

Manufacturers lose new car sales due to lower willingness to pay

- End users invest in ownership more money than they would accept

- Fast depreciation

- ^Excessive

scrappage of cars due to low economic viability of repairs

Pollution by engine exhaust

- Manufacturers bear expenses for conformity of cars to the ever-toughening norms

- Governments spend resources for maintenance of norms

- End users get extra expenses on car maintenance due to added complexity

- A lot of health problems due to harmful emissions

- Climate change and other environmental damages

Inefficient car usage patterns

- Governments, authorities and companies

- Society faces overall life quality

- Environment suffers extraordinary in

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spend extra resources fighting against traffic congestion and lack of parking space

- End users get losses due to higher fuel consumption, higher damage and wear rate in tight traffic conditions

- End users get losses due to time wasted in congestions

fall where there is high density of traffic

the places with high traffic

1.1.2 Sustainability goals

Next question is: how to reach sustainability within all three dimensions?

I have addressed this question by summing up the key economic, social and environmental sustainability goals, means of their achievement, and desirable results after achievement in Table 2.

I assume that some clarifications will be necessary before moving to the table.

Economic dimension.

Each of the three main economic goals show attachment to own category of stakeholders. Effective levelling of economic consequences of social and environmental unsustainability is most relevant for society. Good returns of investments in sales and research & development projects is relevant for manufacturers. Making cars more attractive durable goods to pay for is relevant for end users. Means of advance towards these goals can be described by two concepts: efficiency and transformation. Manufacturers should efficiently use their R&D capital, and authorities should efficiently take congestion and pollution reduction measures. Efficiency is especially important for the society as stakeholder. As we move further to corporate and individual stakeholders, transformation gains greater importance. In conditions of extremely low product sales margins [], improving the share of value added activity becomes highly relevant. According to principles of lean thinking, the common understanding of lean measures throughout entire corporation is a required component for success [4]. So, transformation of business model which not only enables but also secures increase of value added activity, is desirable. For customers this would also be a good possibility to get lower TCO. Today we see that progressively lower

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share of potential first-time car buyers opt for owning a car on developed markets [6], as their priority shifts from a demand for car to a demand for transportation. Various types of mobility-as-a-service concepts emerge nowadays on the background of this. Transformation of the business model is highly related to upcoming transformation of customer value and therefore, car usage patterns.

Social dimension

A sustainable automobile in this interpretation is a topic of interest for both members of industry supply chain and end users of cars, as well as for all traffic participants.

There are certain problems with the realization of the mass-customization concept in the industry, as stated by Wells [5]. Among other sustainability issues, Wells mentions that production concentration and extensive distribution systems lead to long delivery times for customer-ordered cars and high levels of stock in the system. Parry and Roehrich [7] tell on the same subject that the industry suffers from global overcapacity and rising stock levels and exhibits inherently low profitability. Whilst lean thinking has enabled the automotive industry to optimize systems for mass production with minimal waste, it has not tackled the problems of capacity and demand. We find ourselves in a position where a car can be built from flat steel within 11 hours, but a customer ordering a car in a dealership has to wait around 40 days to purchase their desired vehicle or buy one from stock. When manufacturers are still oriented on large scale production, the dealerships can never reach the product variety potential of the supply chain due to the bulky nature of car as a stock keeping unit.

So, the conflict between manufacturers and sales is whether the former should optimize their distribution channels, or the latter should show smarter order planning and build up stocks.

Due to very large size of car plants, their share in work and wealth generation is concentrated into particular locations, poorly spread across the country and society as a whole [5]. This problem displays another conflict of interest – between manufacturers and local societies, that either become highly dependent on the dominating industry, or lack possibilities to offer qualified workforce to this industry at all. A balanced situation is rare within country regions and never happens on a country level.

So, if today we have huge car plants with plenty of dealerships, could the abovementioned problems be solved with transformation of production sites into much smaller integrated cross-functional facilities, given that their amount will be sufficient to effectively function as a decentralized supply chain? And if a workable “all-in-one” concept, unifying all functions related to car lifecycle from manufacturing to recycling under one roof, have

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chance to establish? To this point, these questions are left open, to be addressed later in this work.

Automobiles are made to provide convenient transportation in all inhabited areas.

Convenient here means fast, reliable and acceptable for all traffic participants. However, idling time of about 95% for an average car as well as disorganized and egoistic nature of decision making of traffic participants, in fact, eliminate convenience in the whole idea of the automobile. But, we can clearly observe the development of three powerful trends approaching the industry – it’s connectivity, shared mobility and autonomous driving.

Together they aim to return the privilege to be the most highly-demanded type of transport to automobiles. However, there are various estimates of time frames for mass application of these trends.

Environmental dimension

To be more environmentally sustainable, automobiles should greatly reduce emissions in the atmosphere, and use as little energy and non-renewable resources during the life cycle as possible. The former goal appears to be achievable with electrification of the world car fleet, which is now finally an uprising trend, especially in some countries.

Other alternative power sources for use on cars are developing as well, but electricity has recently become the front-runner in this race. It can also greatly contribute to the latter goal, simply because of high output-input ratio of an electric motor: up to 98%. There are many factors of facilities design, that can allow for better energy use along the car life cycle. But, staying in the framework of this research, I would name best practices of design for maintenance, retrofit and remanufacturing the key factors that should be changed in automobile design for better environmental sustainability of cars. This has potential to save incalculable amounts of man-hours in car workshops and prolong lifecycles of cars and components.

Dimension Goal Means of advance Desirable results

Economic Effective levelling of economic

consequences of social and environmental unsustainability

- Efficient usage of R&D capital by manufacturers

- Efficiency of congestion and pollution reduction measures taken by authorities

- Lower economic burden for end users from cars that are built to last

- Lower economic burden from more efficient traffic

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Good returns of investments to automobile makers in their sales and research &

development projects

- Efficient usage of R&D capital by manufacturers

- Transformation of business model, allowing for higher share of value added activities

- Lower economic burden from cleaner environment

- Lower fixed costs - Lower financial risks at introduction of new car models

- Realization of mass-customization potential

- Flexibility in response, shorter lead times, later configuration

- Flexibility in factory design Making cars more

attractive durable goods to pay for, in terms of TCO and total share of utilization time during life cycle

- Transformation of business model, allowing for higher share of value added activities

- Transformation of car usage patterns and customer value (need for car -> need for

transportation)

Social Eliminate conflicts between

manufacturers, sales and customers

- Transformation of production sites into integrated cross- functional facilities

- Balanced communities of true automobile professionals

- Realization of mass-customization potential

- Reliable and speedy transportation Provide speedy and

reliable

transportation in all inhabited

environments

- Reduction of idling time and more efficient total fleet capacity usage

- Decision making in traffic out of common interest

Provide comfortable traffic environment for all participants

- Decision making in traffic out of common interest

Environmental Reduction of harmful emissions by motor vehicles

- Electrification of daily car fleet

- Development of other alternative fuel types

- Cleaner environment

- More efficient resource usage

Reduction of total external

consumption of

- Electrification of daily car fleet

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energy and non- renewable resources by a car during the whole life cycle

- Development of Design for maintenance/

retrofit/remanufacturing best practices

1.1.3 Barriers on the way to sustainability

Surely there are issues that can and will inhibit the rebirth of the car industry to some extent. Here are those I would characterize as the most significant.

The car industry in the developed world consists of highly concentrated actors, and by today is marked by relatively low returns on investments. This makes competition harsh with differentiation as a must-have skill. Car makers up to nowadays have been very reluctant and/or cautious in introduction of sustainable innovations, because of high uncertainty in terms of returns on investments in them. The new common car production culture is developing only now, raising the overall confidence. Still, car makers, caught between society demands, market and government regulations, and their own financial ambitions, must take hard decisions. They must continue to differentiate, test strategies and predict behavior of competitors in order to prevent their own market shares from shrinking.

Buying and utilization habits are another restrictive factor on the way to sustainability of automobiles. End customers are naturally cautious to the ground-breaking technologies when it concerns such a costly thing as a car. This is especially a characteristic of markets in developing countries. Transparency should always be present in innovative car business models, and the customer value must be properly explained [8]. Additionally, customer preferences on local markets should be followed up, as an effective measure of customer retainment.

Furthermore, a poorly controlled and unstructured second-hand market is an issue tightly related to steep value depreciation of new cars. More than that, as mentioned in my previous research [9], car makers in fact consider only the first buyer as an end customer and put very little effort into improvement of perceived quality for second-hand buyers. This concerns not only production technology but also service. Control of entire lifecycle allows for greater market value of used cars, and their longer life cycle before scrapping.

I offer the already named features of micro-size distributed car production facilities as solutions that can successfully counterweight sustainability barrier issues. With many factories of smaller size manufacturers will have much greater flexibility in launching new

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products and implementing innovations, because this will allow for stepwise changes. This way, confidence of manufacturers in return of investments in their projects will rise. Higher regional representativeness of integrated cross-functional facilities will help customers to feel healthier attitude from manufacturers in regard to knowing local needs, clearer explanation of customer value and stronger aftermarket support without intermediates.

Control of entire life cycle will allow manufacturers to gain significant additional income from aftermarket activities and reduce depreciation of new cars. With micro-factories overproduction issue will be much easier to control, because only local market forecasting will be needed. Modular design, rebuilding and remanufacturing will make aftermarket activities more value-added and by this means increase willingness to pay both for new cars and aftermarket service. Altogether, these features will be able to further reduce depreciation of cars during lifecycle and increase longevity.

Sustainability barrier Lacking component Solutions Manufacturers get low returns

on investments and are focused on differentiation rather than on sustainable innovations.

Confidence of manufacturers in profitability of

sustainable innovations

Modular design.

Small production-

distribution-service facilities

Buying and utilization habits restrict end users’ willingness to pay for sustainable

innovations.

Transparency and proper explanation of customer value. Local preferences follow-up.

High regional

representativeness of production facilities, which combine all lifecycle functions.

Second-hand car market is poorly controlled and

unstructured. New cars rapidly depreciate.

Improvement of perceived quality for second-hand buyers.

Modular design.

Control of entire product life cycle.

1.2 How MFR is supposed to solve the problems

The original concept of Micro Factory Retailing for automobile industry is described by P. Wells and P. Nieuwenhuis in 1999 [8]. My suggestions about benefits of its principles for sustainable development of the industry are strongly based on the material I have read

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about MFR. How MFR could be helpful for sustainability? The answers are extracted from the text by P. Wells [5] and put into Table 4.

Category of advantages Economic Social Environmental

Agile business - Investments in new assembly capacity can be incremental and can more easily expand or contract in line with the market.

- Incremental expansion of capacity can also have a geographic component in that new plants can be added to develop new market territories.

- New products can be introduced incrementally, on a factory-by-factory basis, with much lower overall financial risk associated with them.

Standardization - Through

duplication of MFR sites investment savings could be achieved by means of the multiple ordering of machines and equipment and the use of a standardized layout.

- In transport terms, it is more efficient to move components and sub- assemblies rather than complete vehicles.

- Environmental benefits can be achieved because it’s only necessary to move components and sub- assemblies rather than complete vehicles.

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Value capturing - Factories become locations for repair and aftermarket activities (e.g. body panel change, engine upgrades, refitting of interior trim), which allows the manufacturer to benefit directly from them. This eliminates conflict of interest between production and retailing.

- Factories become centers for trade-in vehicle sales and End of Life Vehicle recycling. Material

recovery and

remanufacturing become viable at the local level because transportation costs are often the major barrier to such efforts.

- Factories do not depend absolutely on the continued sale of new cars. This helps to mitigate the tendency to over-production with all associated

environmental and market benefits.

Benefits for customers - New levels of customer care can be built. MFR makes possible flexible response, shorter lead times, and late configuration.

- Modular refit allows for functional flexibility, which allows for realization of true mass customization.

- Consumers may benefit financially from a reduction in depreciation of the vehicle - the largest single cost of new vehicle ownership, which in existing systems is a product of

product wear,

overproduction, and the step-change

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introduction of a new model.

- Customers can be taken around the plant, can meet the people who will make their car, and can thereby feel ‘closer’ to

the product.

Information about customer needs in a particular region goes transparently to the factory management.

Benefits for communities - The MFR

concept allows for creation of local employment in high- value manufacturing activities. It also embodies the desire to increase labor and reduce fixed investment in order to reduce cost, increase flexibility and social cohesion.

- Stronger worker commitment to the product and to customers. The small factories escape from the ‘mass’ culture of traditional high-volume manufacturing.

- Lower social impact of plant closures, as a smaller plant would be closed in each location.

- Manufacturing processes have a lower local environmental impact compared with traditional high-volume manufacturing and even give the option of doing without a paint plant which is generally regarded as the largest single problem area in traditional car assembly.

- MFR does not require a large, flat, dedicated site with extensive support services. A modern traditional car plant occupies several square kilometers of land.

Compared with this, MFR requires a classic

‘light industrial’

facility, and is highly

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suitable for brownfield sites.

Table 4. Potential advantages of MFR

This concept is in essence very simple: the manufacturing operation and the distribution/retail operation are combined in the one entity. Between 25% and 40% of the market price of a car is attributable to the distribution system [5].

The business model has two main aspects by which social sustainability is potentially superior to that offered within the traditional automotive business model. The first aspect is that of enhanced customer access to environmentally friendly products, more closely aligned with their particular needs, along with long-term support. The second aspect relates to labor, where MFR creates the possibility of more varied, interesting and rewarding work along with more stable employment patterns distributed more widely across spatial areas.

More significantly, this change in product technology (which as a by-product can yield lightweight cars of lower environmental burden) and the associated process technologies not only changes the terms of competition, it provides the basis for a more sustainable business model. For example, alternative vehicle architectures and materials are much more conducive to modular repair and retrofit, which in turn means that the economic cost of such activities will be much lower. Therefore, the economic incentive to scrap a vehicle is lower, vehicle longevity can increase dramatically because it can be continually renewed and updated with the latest technologies (with the attendant environmental benefits). The vehicle becomes more of an asset to be retained by the vehicle manufacturer and leased to the consumer, thereby generating stable and long-term income streams.

None of the above actually directly relates to the issue of ownership. For example, this type of structure could be achieved through the fragmentation of an existing vehicle manufacturer, or by a new-entrant start up, or various intermediate business forms.

Moreover, local ownership might be one means whereby communities derive the additional social benefits of local control: a key problem with traditional globalization is that local communities or indeed entire countries feel powerless in the face of large multinational companies [5].

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1.3 How application of MFR in the car industry can be described by Game Theory

Game theory and its methods applicable for this thesis will be described in detail later in the Methodology section. Generally, game theory should aggregate preferences of the manufacturers (referred to as players), driven by abovementioned trends, problems and restrictions, into market development scenarios and final states likely to happen. The thesis will include identification of Nash equilibria in strategic games with simultaneous moves of the players, with strategies of one player to be MFR or traditional car production. Subsequent elaboration on results will also include some thoughts on dynamic games, where strategy choices can reflect degrees of expansion of MFR production or other market competition tactics aimed to improvement of the competitive advantage. However, dynamic games will not be highlighted in the section of results. Static games, according to the scope of this work, will provide enough suggestions to be developed in the section of discussion.

The research will constitute on several hypotheses to be listed in the next sub-section.

In the Discussion section proof or disproof for each hypothesis will be derived. The hypotheses and further elaborations over them will reflect the questions why the MFR model is not practiced in the mass production of cars and which prospects does MFR have in the future automobile industry.

1.4 Hypotheses.

Assumption. MFR is a central tool for reaching sustainability of a business model for a car manufacturer, however, existing manufacturers may find it not rational to undertake a complete change of their business models to MFR. Therefore, its application within the scope of this work will be restricted to only new speculative players on the market. Costs of change to MFR as well as possibility of fractional change, are not included in the scope of this work.

H1. MFR is more suitable for custom production, than for mass production.

H2. Existing players will find it more rational to fight newcomers that apply MFR business model, rather than accept.

H3. MFR startups will be unable to affect actions of other players in case of active rivalry.

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2.0 Methodology

2.1 Why Game theory?

Game theory is a theory that deals with the situation when one individual’s actions depend on what other individuals may do. It is concerned with how several individuals make decisions when they are aware that their actions affect others and when each individual takes this into account [10]. According to OICA report [11], 17 car makers with international presence have made 80% of all cars in 2016. Given that today’s car market hence is close to an oligopoly, this study considers game theory as an appropriate tool for decision makers in the industry to predict market development.

A game normally consists of a set of players with strategies that are available to them. The outcome is the result from the sequence of actions played by all players, with each player hoping to achieve their own desired outcome [12].

The gap in knowledge that is supposed to be reduced by means of this study, exists due to very insignificant amount of research made both within fields of game theory and innovation [13]. Automobile industry, one of the world’s most capital-intensive industries, faces rapid structural changes. Decision makers deal with uncertainty, so they increasingly need reliable tools for scenario forecasting. I believe that the development of this study can become one of such tools.

Game theory in the framework of this study allows for modelling of market development situations by means of static and dynamic games. Adoption of the MFR concept is supposed to be described here using the basic elements of a game. Players are car manufacturing companies. Rules of the game specify three things: timing of players’ moves, actions available for the players, and information available for the players at each move.

Outcomes are the sets of actions taken by the players. Payoff for each player could then be defined as a measure of competitive advantage of the player in the end of the game.

2.2 Game models

Static games in normal form will be applied to simulate different market situations and see where Nash equilibrium should be expected, given the outcomes. There will be two players in each variant of the game: a newcomer on the market (startup), and a group of established manufacturers (cluster), representing a market segment the newcomer is aiming to occupy. The startup’s strategies will be to choose MFR (“MFR”) and to go for traditional

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business model (“no MFR”). The cluster will choose between strategies “Fight” or “Accept”

startup, where “Fight” means taking measures within marketing, research and development, supply chain management or customer service, aimed for further improvement of existing competitive advantage. Outcomes will represent simple superiority of customer preference of one player over customer preference of its opponent after the actions are completed. This superiority is believed to be the determinant of the market success of a winning player. The characteristics that will shape game outcomes are a logical estimate, are discussed in Section 3. An example of a such normal form game is shown on Fig. 1. Payoff figures are exemplary;

they stand for degree of customers’ preference (number of cars sold), as compared to that of the outcome {MFR;Fight}, which is [x;y].

Fight Accept

MFR x; y 1,5x; 1,5y

No MFR 2x; y 3x; 2y

Fig. 1. Example of the static game “MFR vs. traditional car manufacturing”. Payoffs show relative customer preferences for each player after implementation of the chosen strategy.

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3.0 Results (facts of research)

3.1 Data

The European car market showed sales volume of 15,6 million of passenger cars in 2017. This is about 20% of world car sales the same year, which makes the European market relevant as the unit of analysis in this work. I use the detailed data for 2017 provided by ACEA [14] for description of market shares of the players, and data from ICCT 2017 report [15] to demonstrate market trends and historical development.

Fig. 2. New passenger cars registrations by class, 2001-2016.

New registrations by class in 2001 through 2016 are shown on Fig. 2. The graph shows that the total increase in sales during this time is almost solely provided by contribution of SUV class share. This class have risen in sales figures by 550% during the whole period, while the other classes showed 2016 values 50-110% compared to 2001.

Customer preferences leaning to SUV is one of the clearest trends on the car market today.

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Fig. 3. New passenger cars registrations by brand, 2001-2016

New registrations by brand for the same period are on Fig. 3. BMW and Audi are the only producers that show significant growth in sales with more than 150% new registrations in 2016 compared to 2001. BMW, Audi, Mercedes-Benz, as well as FIAT, Renault and Opel showed considerable and stable growth rate in 3-4 years up to 2016.

Meanwhile, Volkswagen, Ford, Peugeot and Citroen have not been on the rise.

The ICCT report shows that Toyota is the market leader in the segment of hybrid electric vehicles, with a rapidly growing share in the total sales volume. About 37% of new Toyota passenger cars registered in Europe in 2016 have been hybrid electric, while other manufacturers showed either moderate growth or decline of this share. In the segment of plug-in hybrids and electric vehicles, BMW and Mercedes-Benz have been on the rise with 4% and 1,8% share in the total sales volume respectively, while others showed no rising trend and no more then 1,7% share. Another trend is the increasing share of new cars with start-stop technology, where Audi, BMW, Mercedes-Benz, Volkswagen and Renault are leaders with the share of new passenger cars with this technology approaching 100%. I will let myself derive the innovation level of the players from these data, displayed on Fig. 4.

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Fig. 4. Determinants of players’ innovation level.

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Fig. 5. Determinants of players’ prestige level.

Fig. 5 shows development of average engine power, mass, size and pricing for each leading manufacturer (with more than 5% market share in 2016) for the period of 2001- 2016. I define them in this study as determinants of prestige level of the players.

Report by ACEA [14] depicts sales volumes and market shares of 32 car manufacturers introduced on the European market in 2016 and 2017, by exclusion of only some few brands with very low sales figures (top class prestigious brands). The important detail to emphasize is that, unlike the ICCT report, which includes numbers of new registrations, ACEA report features numbers of sales. For each manufacturer these two figures may differ, but still the picture of market share distribution is identical in both reports. The data from ACEA report appear preferable for this study, because they include more manufacturers and are available for 2017. They are introduced in Table 5.

The introduced data will be used as a framework for classification of the players by groups. Grouping will make it possible to simulate games with various outcomes and by this means to make the further analysis more realistic.

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Carmaker Sales 2017 Sales 2016 % Change 16/17 % Share 2017

EU & EFTA 15,631,687 15,131,719 3.3 100.0

1 – VOLKSWAGEN 1,706,369 1,721,899 -0.9 10.9

2 – RENAULT 1,150,498 1,101,221 4.5 7.4

3 – FORD 1,031,957 1,034,635 -0.3 6.6

4 – OPEL (PSA & GM) 943,227 993,464 -5.0 6.0

5 – PEUGEOT 925,113 864,565 7.0 5.9

6 – MERCEDES 893,574 839,779 6.4 5.7

7 – BMW 827,137 822,724 0.5 5.3

8 – AUDI 826,370 830,933 -0.5 5.3

9 – FIAT 779,534 746,197 4.5 5.0

10 – SKODA 705,421 663,147 6.4 4.5

11 – TOYOTA 673,510 593,760 13.4 4.3

12 – CITROEN 569,728 541,561 5.2 3.6

13 – NISSAN 566,191 550,584 2.8 3.6

14 – HYUNDAI 523,258 505,377 3.5 3.3

15 – DACIA 472,800 421,644 12.1 3.0

16 – KIA 472,125 435,316 8.5 3.0

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17 – SEAT 400,968 350,508 14.4 2.6

18 – VOLVO 303,312 291,473 4.1 1.9

19 – SUZUKI 244,877 202,949 20.7 1.6

20 – MAZDA 231,925 237,034 -2.2 1.5

21 – MINI 215,443 209,116 3.0 1.4

22 – LAND ROVER 151,566 153,071 -1.0 1.0

23 – HONDA 140,343 159,187 -11.8 0.9

24 – MITSUBISHI 114,182 117,086 -2.5 0.7

25 – JEEP 108,655 105,015 3.5 0.7

26 – SMART 98,954 105,295 -6.0 0.6

27 – ALFA ROMEO 85,691 66,167 29.5 0.5

28 – PORSCHE 73,456 71,172 3.2 0.5

29 – JAGUAR 69,473 68,687 1.1 0.4

30 – LANCIA/CHRYSLER 60,805 67,230 -9.6 0.4

31 – DS 45,864 65,656 -30.1 0.3

32 – LEXUS 44,339 44,658 -0.7 0.3

Table 5. Car sales on European market in 2016 and 2017 by manufacturer.

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3.2 Choice of players

Based on the market data shown in the previous section, I have created a classification of the market players. This classification uses two-dimensional space, formed by axis named “Prestige level” and “Innovation level”. Today car manufacturers experience low sales margins and high necessity to differentiate. I believe that namely levels of prestige and innovation are the categories that define customers’ perception of differentiation of a car make as a whole in the most correct way. The diagram on Fig. 6 shows how differentiated are the manufacturers in the European car market from the perspective of their location along the axis “Prestige level” and “Innovation level”. Market shares of each manufacturer are added for better overview. Based on their position on the diagram, players are classified into different groups. When the games will be played, startup (row player) will always play with each of the groups (column player). Then, outcomes and payoffs may depend on the particular combination of players in the game.

Fig. 6. Grouping of market players by differentiation.

The classification results in 6 groups of players. Together the 24 players introduced in the groups, account for over 87% of the market volume in 2017.

Group 1 – Flagships. The members of this group are highly differentiated by both prestige and innovation, which is confirmed by their maximum brand strength in Europe and the world. Audi, BMW and Mercedes-Benz take close market shares and have good control in most of the market segments. Smart and Mini are compact car brands for Mercedes-Benz

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and BMW respectively. The German “Big Three” pays highest attention to technologies and promotion and has got global market presence long ago. Tesla, on the contrary, have entered the market very recently. It is included here despite low market share, not only because of the brand’s ability to innovate and the iconic image, but also due to the high brand exposure in Norway, the country where the present study come from. All the members of the first group set justifiably higher prices for their cars, compared to closest competitor models from other groups. They also tend to work on the customers’ perception of their brands as more

“approachable” by offering top class models in non-premium market segments. The total market share of the Flagships is 18,5%

Group 2 – Flagship Candidate. Volvo is striving to establish in the quadrant of Flagships with its active renewal of the product line. It’s image of the safest car make is still robust and honed with the cutting-edge technologies. Volvo’s pricing level is therefore can be directly compared to that of Flagships. Still, moderate width of the product range and overall low market share (1,9% in 2017) prevent Volvo from being included in the first group so far.

Group 3 – Technology Mainstream. This group includes members with somewhat different background, but their high progress in innovation to the time of this study is recognized, not least due to strong positions in the segments of electric and hybrid cars.

Volkswagen with its 10,9% market share in 2017 (highest among all the manufacturers), has the highest brand power in the group, and the highest presence in product segments.

Volkswagen, Renault and Toyota are included in large multinational corporations which ensure them high ability to retain market positions through corporate cooperation. Given lower prestige level, compared to the Flagships, members of this group set moderate pricing for the cars. They also have more widespread physical distribution channels. Because of the ongoing major technological changes in the car industry, I estimate that Technology Mainstream companies, taking together 22,6% of the market, are soon going to experience much fiercer competition due to new establishments inside their group.

Group 4 – Technology Candidates. I have judged these players to form a separate group, however they start to make a direct competition to group 3, especially Peugeot with 5,9% market share. Citroen is included in group PSA together with Peugeot, while Nissan belongs to alliance with Renault, and Skoda is a part of VAG together with Volkswagen, Audi and other manufacturers. Nissan is represented globally on the market, while other members have less global presence. The power of alliances and high ambitions of

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participants of group 4 allow to estimate that they have high chances to enter competition in Group 3. Together the Technology Candidates take 21,6% of the market.

Group 5 – Budget Mainstream. Ford, Opel, FIAT, Hyundai and Kia stand out from others as cost leaders. Opel have been acquired by group PSA in 2017 and so far, it hasn’t shown any intention to change strategy. FIAT is particularly strong brand in Italy and Poland, and it has overall good brand exposure in compact car classes. The total market share of the Budget Mainstream is 23,9%.

Group 6 – Premium. The most remarkable premium brands by market share are Jaguar, Alfa Romeo, Land Rover, Porsche and Lexus, even though none of them have exceeded market share of 1,0% in 2017. The total market share of the Premium companies is 2,7%.

3.3 Estimation of payoffs

Payoffs in games will be estimated with help of following characteristics, applied to both types of players: Brand strength, Product variety, Customer service, Innovation rate, Pricing model, Promotion strength. Values of the characteristics can be: “0” or “1” for Cluster / Player 1 and “+”, “-“ or “+/-“ for Startup / Player 2. The values are of schematic character and based on my personal estimate based on the common knowledge and marketing mix reviews for existing car manufacturers [16]. Specific values for players are displayed in Table 6.

For Startup/Player 1, a “+” value means definite competitive advantage over Cluster/Player 2 in a particular characteristic, a “-“ value means stands for definite competitive disadvantage. A ”+/-“ value shows that a startup can adequately compete with a group of existing companies, but the stability of competitive advantage depends on the strength of the opponent. For Cluster/Player 2 value “1” stands for presence of strength, or ability to replicate the competitive advantage of the startup and “0” stands for lack of strength, or inability to replicate the advantage in the respective characteristic. Thus, in the short time perspective (3 years, according to the scope of this research) performance of a ”1”

player is considered impossible to exceed by that of a “+/-“ startup player, but a “0” player can be beaten by a “+/-“ startup in a particular characteristic. If Cluster/Player 1 chooses strategy “Accept”, its strength in all characteristic except Brand strength is considered to become “0” (so that only “-” startups will certainly have disadvantage in the particular characteristic). The Brand strength of ”1” players will still be “1” even if they choose

“Accept”. The summary of the advantages in all characteristics will be drawn for each game,

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with elaboration and conclusion about the market forecast for the startup. An example of payoff assessment is in the Table 7.

Cluster (column player / Player 2) – strategy

“Fight” (strategy “Accept”)

Startup (row player / Player 1) Group

Characteristic 1 2 3 4 5 6 MFR No MFR

Brand strength

1 (1)

0 (0)

1 (1)

- -

Product variety

1 (0)

0 (0)

1 (0)

0 (0)

+/- -

Customer service

1 (0)

0 (0)

1 (0)

+ +/-

Innovation rate

1 (0)

0 (0)

+/- +/-

Pricing model

0 (0)

1 (0)

0 (0)

- +/-

Promotion strength

1 (0)

0 (0)

+/- +/-

comment Interpretation of sub-outcomes (components of the total outcome, related to each characteristic):

[“-“; ”0”], [“-”; “1”] – Startup/Player 1 is not able to compete with Cluster/Player 2 in this characteristic. Cluster/Player 2 wins.

[“+/-“; ”0”], [“+“; ”0”] – Startup/Player 1 is able to compete,

Cluster/Player 2 cannot replicate the advantage. Startup/Player 1 wins.

[“+/-“; ”1”] – Startup/Player 1 is able to compete, Cluster/Player 2 can replicate the competitive advantage. Cluster/Player 2 wins.

[“+“; ”1”] – Startup/Player 1 is able to compete, Cluster/Player 2 can replicate the advantage only in the short run . Startup/Player 1 wins.

Table 6. Values of the characteristics for customer preferences for the players.

Customer preferences in each characteristic can be in favor of either player, but never equal. So, if, like in this example, one player is preferred by customers in 5 characteristics, the opponent will be preferred in 1. The standard assessment is always applied to the outcome {“MFR”; ”Fight”}. The number of customer preference winnings is summed up

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for each player and equated to x for Startup/Player 1 and y for Cluster/Player 2. Payoffs for all the other outcomes will be then expressed through x and y.

Startup Cluster

Brand strength ×

Product variety ×

Customer service ×

Innovation rate ×

Pricing model ×

Promotion strength ×

Result x y

Table 7. Example of assessment of payoffs for a game outcome {“MFR”; ”Fight”}.

As the next step, I will explain assignment of values to the different players in the Table 6.

Brand strength. Flagships, Volvo, Technology Mainstream and Premium have stronger brands than Technology Candidates and Budget Mainstream. Mercedes-Benz, BMW and Audi have earned it over many years (although the least two – more recently) by means of systematic effort in differentiation towards brand superiority. Tesla, a player which is only 10 years on the world market, is now the strongest brand in the electric vehicles segment thanks to impressively competent marketing of the Model S and accompanying active development of the production of electric vehicle components. Volvo has wide recognition by the public as the manufacturer with the strongest focus on car safety.

Volkswagen proves its brand strength with the highest market share in Europe, Toyota has secured its position due to the visible result of the forward-looking approach to quality management, and Renault has been able to appear in the same group as an effect of diversified and adaptive market policy with attention to the idea of “value for money” as well as skillful promotion through racing events. Premium brands, although serving a very limited part of the market, are strong because of the exclusivity, ensured by the excellent customer focus. It is generally not expected from a startup in the automobile industry to show the strength of the brand comparable to that of the established competitors, simply because this characteristic is always earned over some period, even though (as with Tesla) this period doesn’t necessarily have to be very long. The important notice about Brand strength is that it is always the same for Cluster/Player 2 regardless of the choice of strategy,

A way to sustainable automobile production: game theory view

Master’s degree thesis

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